Chapter 3: Budgetary Planning and Control

Introduction

Learning Objectives

3.1 Functional Budgets

Activity 3.1: Master Budget

3.2 Fixed Budgets and Flexible Budgets

Activity 3.2: Flexed Budget

Example: Elizabeth’s Boutique

The Sales Budget

Purchases Budget (in Units)

Purchases Budget (in £s)

Master Budget

Budgeted Income Statement

Cash Budget

3.2.1 Fixed Budgets

Example: Lal TeddyBears

3.2.2 Flexible (Flexed) Budgets

3.2.3 Flexible Budgeting in Practice

This chapter builds upon Book 6, focusing on the practical application of budgeting in management accounting. It covers the preparation of annual budgets, monitoring actual results, and responding to variances from the plan (as outlined in Figure 2.2 in Book 6).

Understand various types of budgets.
Prepare cash budgets for planning and control.
Explain the difference between fixed and flexed budgets.
Prepare flexed budgets for planning and control.
Apply standard costing techniques to calculate variances.
Analyze variances.
Understand the limitations of standard costing and variance analysis.

A functional budget is a detailed budget for a specific function within a business, such as sales, production, purchases, personnel, or marketing. The function can be a cost center, profit center, or investment center, each requiring its own budget.

Elizabeth starts a bridal dress boutique with a £30,000 initial investment for fixtures (£22,000) and inventory. Dresses sell for £400 each and cost £150 to buy. Monthly expenses (rent, lighting, heating, rates) are £6,000. Sales forecast for the first seven months is:

Jan: 20
Feb: 30
Mar: 30
Apr: 40
May: 60
Jun: 80
July: 90

In this case, sales demand is the limiting factor. Budgets for limiting factors are prepared first.

The sales budget is usually produced first, as sales demand is often the limiting factor.

Table 3.2: Sales Revenue Budget (First Six Months)

	Jan	Feb	Mar	Apr	May	Jun	Total
Volume	20	30	30	40	60	80	260
Revenue	£8,000	£12,000	£12,000	£16,000	£24,000	£32,000	£104,000

The sales revenue is calculated by multiplying monthly sales demand by the selling price (e.g., January: $20 \times £400 = £8,000$ ).

It's recommended to keep 20% of the next month’s sales as closing inventory. The business has no opening inventory in the first month.

Table 3.3: Purchases Budget (in Units)

To calculate the cost of purchases, multiply the number of dresses purchased each month by the purchase price (e.g., January: $26 \times £150 = £3,900$ ).

Table 3.4: Purchases Budget (in £s)

	Jan	Feb	Mar	Apr	May	Jun	Total
Purchases Required	26	30	32	44	64	82	278
Cost	£3,900	£4,500	£4,800	£6,600	£9,600	£12,300	£41,700

Functional budgets are reviewed, coordinated, and combined into the master budget, which includes:

Budgeted Income Statement
Budgeted Balance Sheet
Cash Budget

Elizabeth's Boutique Income Statement (First Six Months)

Sales ( $260 \times £400$ ): £104,000
Less: Cost of Goods Sold ( $260 \times £150$ ): (£39,000)
Gross Profit: £65,000
Expenses ( $£6,000 \times 6$ ): (£36,000)
Budgeted Profit: £29,000

Additional information is needed regarding payment timings for expenses and cash receipts from sales. Assume:

Fixtures are installed in December, paid in January (£22,000).
Purchases are on one-month credit.
Sales are cash.
Overheads are paid in the month they occur (£6,000 per month).

Cash Budget (Six Months to June 20X5)

	Jan	Feb	Mar	Apr	May
Cash Receipts
Cash Sales	£8,000	£12,000	£12,000	£16,000	£24,000
Total Cash Receipts	£8,000	£12,000	£12,000	£16,000	£24,000
Cash Payments
Purchases	-	£3,900	£4,500	£4,800	£6,600
Overheads	£6,000	£6,000	£6,000	£6,000	£6,000
Fixtures and Fittings	£22,000	-	-	-	-
Total Cash Payments	(£28,000)	(£9,900)	(£10,500)	(£10,800)	(£12,600)
Surplus/Deficit	(£20,000)	£2,100	£1,500	£5,200	£11,400
Balance b/f	£30,000	£10,000	£12,100	£13,600	£18,800
Balance c/f	£10,000	£12,100	£13,600	£18,800	£30,200

The cash budget estimates £40,900 at the end of June 20X5. This information assists in business planning and control.

Prepare a cash budget, budgeted income statement, and balance sheet for David’s Pizza for the six months to 30 June 20X6, and comment on the cash position, using the provided balance sheet as at 31 December 20X5 and forecasts for the next six months.

A fixed budget is prepared at the start of the budget period for planning and control. It's based on an estimated volume of activity and isn't adjusted for actual performance during the control period. Comparing a fixed budget with actual results shows the difference between the original plan and actual performance.

Fixed budgets can cause issues when the actual activity level differs from the budgeted level.

Lal TeddyBears sells handmade teddy bears for £15 each, with a direct cost of £10 per bear. The business expects to sell 1,000 teddy bears in January 20X5.

Table 3.5: Budget for January 20X5

Sales ( $£15 \times 1,000$ ): £15,000
Direct Materials ( $£2 \times 1,000$ ): (£2,000)
Labour ( $£8 \times 1,000$ ): (£8,000)
Contribution: £5,000
Fixed Overheads: (£4,000)
Net Profit: £1,000

Actual performance in January:

Table 3.6: Actual for January 20X5

Sales ( $£14 \times 1,500$ ): £21,000
Direct Materials ( $£1 \times 1,500$ ): (£1,500)
Labour ( $£9 \times 1,500$ ): (£13,500)
Contribution: £6,000
Fixed Overheads: (£4,000)
Net Profit: £2,000

The business doubled its profit in January. However, the increased sales volume makes it difficult to compare with the initial budget. Fixed budgets don't account for volume changes. To address this, we use a flexed budget.

Flexible budgets adjust to changes in activity levels. Fixed costs (rent, rates) remain constant within the relevant range. Variable costs change in proportion to activity, while semi-variable costs have fixed and variable components.

Flexible budgeting recognizes the cost behavior pattern of each item by revising the original (fixed) budget based on the actual activity level.

To prepare a flexible budget for Lal TeddyBears, adjust for the sales of 1,500 units:

Table 3.7: Flexed Budget

Sales ( $£15 \times 1,500$ ): £22,500
Direct Materials ( $1,500 \times £2$ ): (£3,000)
Labour ( $1,500 \times £8$ ): (£12,000)
Contribution: £7,500
Fixed Overheads: (£4,000)
Net Profit: £3,500

The profit should have been £3,500, indicating that actual performance was not as good as expected, considering the increased sales volume.

Flexible budgeting can be implemented by preparing a series of budgets for different activity levels or by reworking the budget allowances at the end of the accounting period when the activity level is known.

Sales Volume

Less: Opening Inventory

Add: Closing Inventory (20%)

Purchases Required

EasyCarry manufactures luxury laptop bags. The standard selling price is £80, with the following variable costs:

Direct Materials: £5 (1 kg @ £5 per kg)
Direct Labour: £18 (2 hours @ £9 per hour)
Direct Machine: £4 (1 hour @ £4 per hour)
Prime Cost: £27

The business plans to sell 1,400 bags in six months, with fixed overheads of £30,000. Actual sales were 1,800 units, and actual fixed overheads were £30,000. Actual unit selling price was £75, and variable costs were:

Direct Materials: £6 (1.5 kg @ £4 per kg)
Direct Labour: £15 (1.5 hrs @ £10 per hr)
Direct Machine: £5 (2.5 hrs @ £2 per hr)
Prime Cost: £26

Prepare a fixed budget, a flexed budget, compare it with actual performance, and comment on the business's performance.